Households would be able to choose their water supplier for the first time under proposals from Ofwat which it claims would cut bills and improve services by introducing competition.

However, the proposed overhaul of British water supply would only save households about £8 a year on their water bill, the industry watchdog said.

Under the existing system homeowners can only buy water from a handful of regional suppliers such as Yorkshire Water, Severn Trent or Thames Water. But a report by Ofwat suggests restructuring the industry to encourage new entrants to the market in an effort to improve services and bring down bills.

The new regime would allow private companies to buy water in bulk from the existing major suppliers and sell it on to households.

They could also offer packages including other services such as gas or electricity, Ofwat said.

The plan echoes a similar overhaul of water supply to businesses, which will be able to switch their supplier from next April. Large industrial users of water can already switch suppliers.

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Ofwat said there would be significant costs in opening up the market which would “ultimately fall on companies and customers”.

“It is for the government to decide whether in principle it wants to introduce competition and, if so, how and when to do so,” it said.

Cathryn Ross, Ofwat’s chief executive, said greater competition would benefit customers by encouraging firms to offer better services, such as allowing them to manage their bills with a mobile phone app.

“We are living in an age of retail revolution, but water customers are being left behind,” said Ross.

“The service offers from water companies can feel behind the curve compared to the innovation customers benefit from when buying other goods.

“The uncomfortable truth is that, when it comes to retail offers, water companies provide an analogue service in a digital age.”

Water UK, which represents the water companies, said: “Extending retail competition to over 20m households could secure potential benefits for domestic customers, but would also be a major undertaking and so deserves to be given very careful consideration.

“We look forward to a timely decision from government which helps sustain the stability the industry needs to continue successfully meeting the needs of its customers.”

The government has to approve any proposals before the market is opened up.

Ofwat’s intervention comes after it was criticised by MPs on the public accounts committee, who blamed the regulator for allowing bills to rise too much.

The committee said Ofwat habitually overestimated water companies’ costs, allowing them to inflate bills.